Cash Management

The Picture of Health: Cash at Medical Midcaps

Compared with four other industries – the machinery, software, internet, and semiconductor sectors – health-care companies in the CFO Midcap 1500 p...
David KatzJuly 8, 2009

Editor’s note: To download a Microsoft Excel file containing the full results of the CFO Midcap 1500 Healthcare Industry Scorecard,

click here.

The best decision CFOs working for midcap companies in the health-care industry can make if they want to provide shareholders with bundles of cash is, well, to be working for midcaps in the health-care industry.

That’s because the operations of medium-sized health-care products and services companies make remarkably steady amounts of cash available to investors in their stock each year. To be sure, health care has a seasonal aspect — think of those New Year’s resolutions to diet and join health clubs and how many of those vows are broken in a few months. Mostly, however, the industry enjoys a consistent stream of customers because people get sick and are hurt in accidents all year round. Other factors, including its tendency not to get too deeply in debt and its paucity of price competition, add to the industry’s inherent ability to produce cash.

Take Air Methods Corp., a company that flies patients via helicopters to get treatment at the right health-care facilities. For the first quarter of this year, the company recorded $1.32 in cash earnings per share, the most of any in a group of 41 health-care companies culled from the CFO Midcap 1500 index. The index, created by CFO and based on publicly reported data provided by Capital IQ, consists of publicly traded companies with 2009 first quarters ending March 31 that have yearly revenues of between $100 million and $1 billion. The companies are ranked according to cash EPS, which is calculated by dividing a company’s operating cash flow by its diluted shares outstanding.

Fueled by a 6% rise in revenues, Air Methods boosted its cash EPS by 62% in the first quarter of this year relative to the first quarter of 2008. Asked what the company had done to kick out so much more cash to its shareholders, Trent Carman, the company’s CFO, secretary, and treasurer, told that it would be a mistake to say it was any management actions that boosted operating cash flow. “It’s the business,” he explained. “It’s a heavy cash-flow business all by itself.”

In that respect, Air Methods is typical of how well health-care midcaps stack up against companies in other kinds of business. Compared with four other industries — the machinery, software, internet, and semiconductor sectors — health care produced the highest 2009 first-quarter cash EPS, 32 cents.

That’s a 30% rise over the first quarter of 2008 — and testimony to the industry’s ability to produce cash even during the worst of times. Indeed, health-care midcaps saw their aggregate revenue jump from $3.70 billion in the first quarter of 2008 to $3.98 billion in the same quarter of this year.

How have these companies managed to hold their own so well? One reason is that they’re “more likely to have pricing power and therefore improved margins,” said John Sullivan, director of research at Leerink Swann, an investment bank focusing on health-care companies. The reason is circular: because they often must hatch innovative products and business models to compete, health-care midcaps are less likely to face direct competitors than companies in other fields might. Thus, they have more control over what to charge customers, according to Sullivan.

Another reason is that health care is less volatile than other parts of the economy. “It does not go up and down, and therefore companies don’t have to build their infrastructures when the economy [performs well] and then suffer” when it dips, he said. “The infrastructure is more likely to be right-sized to their ongoing business, and for that reason they can optimize cash flow.”

A third factor in their ability to generate cash is that they don’t tend to be highly leveraged. They can take steps to improve their businesses rather than having to focus on paying down their debt, said Sullivan, who noted that that tends to spawn “high-quality balance sheets.”

Nevertheless, finance execs in this sector aren’t merely sitting back and enjoying their good fortune. Citing Air Methods’ large billing and collection department, Carman said that abundant incentives for collecting higher amounts of accounts receivable are built into the compensation structures of those professionals.

Further, a unique component of the company’s financial picture is the price of fuel for its helicopters. Although the company’s cost of aircraft fuel per hour flown dove by about 35.4% for the first quarter of this year compared with the same 2008 period, the company is managing the risk of an upward swerve in prices. In the fourth quarter of 2008, it entered into a fuel-derivative agreement that hedges most of its projected fuel consumption for the year ending December 31. The derivative protects the company against increases in the cost of Gulf Coast jet fuel above $2.35 per gallon for wholesale purchases.

At some companies, having a stated corporate goal of cash generation may make it more likely to be achieved. “We have a saying around here that cash is queen,” says Mary Chaput, the CFO of Healthways Inc., which runs wellness and disease-management and programs for hospitals, health plans, and small businesses. She cites an “aggressive cash-management initiative” that functions on a daily basis, increased monitoring of receivables, and cost-containment efforts that push employees to treat their travel expenses “as if every dollar were their own” as contributing factors to the company’s stellar cash numbers.

Perhaps partly as a result of such efforts, Healthways spawned $1.14 in cash EPS in the first quarter of this year, the second-highest figure for a company in the health-care segment of the CFO Midcap 1500, and 97% over the amount it produced in the same quarter a year ago. And it did so despite sharply slowing revenue growth (just 1% in Q1 of 2009 after a 55% surge in 2008) and a slight decrease in gross margin (from 29.2% to 27.3%).

On the receivables front, the company has set up an electronic billing system in which health plans deposit funds each month into accounts that Healthways set up for them. The company is also keeping a close watch on its accounts payable and its bank debt. Each week, for example, representatives of the company’s treasury department meet with finance and operations people to dope out “where the trouble spots are” in terms of bills it must pay, says Alfred Lumsdaine, the company’s controller and chief accounting officer.

Healthways finance executives also ponder on a weekly basis how much of its $400 million revolving bank loan, which terminates on December 1, 2011, to pay off. At the end of the first quarter, the credit facility had a balance of $119 million, with $281 million in available credit. “The last thing we want is net debt on our balance sheet,” the controller said.

At the same time, the company apparently hasn’t been immune to the economic downturn. Healthways laid off 150 employees in May 2008, following that up with 100 in November of that year.

Overall, while health-care midcaps seem to have endured the recession relatively well, they do face substantial risks if unemployment continues to rise and the numbers of the uninsured correspondingly mount. “The risks to working capital in the health-care industry are all around the end customer — the patient — being able to pay,” says Leerink Swan’s Sullivan.

Those risks may be greater for companies, like Air Methods, that don’t screen out customers on the basis of their inability to pay. “To the extent that unemployment goes up and the number of those who are uninsurable goes up, our receivables will rise,” predicts Carman. “The biggest headwind for ’09 is the state of the economy.”


2009 Q1 CFO Benchmark_Healthcare